Philippines Faces Post-Arbitration Dilemma Over Reed Bank

Would Manila accept exploration of Reed Bank or joint development on Chinese terms?

By Jeremy Maxie for The Diplomat

July 12, 2016

With the Permanent Court of Arbitration (PCA) award on the territorial dispute between the Philippines and China announced on July 12, events in the South China Sea (SCS) remain seemingly locked in a cycle of escalation with no clear resolutions. Having strongly denounced the PCA’s legitimacy, China is widely expected to respond defiantly in the near future.

Several anticipated moves include announcing an Air Defense Identification Zone (ADIZ), further militarizing existing artificial islands (with offensive assets), initiating land reclamation in Scarborough Shoal, or reimposing a blockade of Second Thomas Shoal. An ADIZ would be easy to declare, difficult to enforce, and likely ignored; meanwhile offensive military assets (such as fighter jets or missiles) deployed to China’s artificial islands could be readily withdrawn.

However, land reclamation at Scarborough Shoal or a blockade at Second Thomas Shoal would carry significant escalation risks—including potential military conflict between China and the Philippines that could draw in the United States. Such aggressive and risky moves immediately following the arbitration award would likely undermine nascent opportunities for rapprochement between Beijing and the new government in Manila.

Considering the risks and tradeoffs, Beijing may instead choose to engage in a potentially less destabilizing option—presenting Manila with a choice between China’s unilateral exploration of Reed Bank or joint development on China’s terms. This could prove a compelling proposition for Manila since Reed Bank (Recto Bank), located approximately 80 nautical miles northwest of Palawan within the Philippine Exclusive Economic Zone (EEZ) but claimed by China, is thought to hold one of the highest concentration of undiscovered resources within the SCS—764 million to 2.2 billion barrels of oil and 7.6 Tcf to 22 Tcf of natural gas.

While Reed Bank’s potential resources are modest relative to China’s massive energy consumption, the area is essential to Philippine future energy security. In particular, the Philippines is looking to develop Reed Bank to replace the Malampaya gas field, also located offshore west of Palawan, that is expected to be depleted by 2024-2030. The Malampaya gas-to-power project, led by Royal Dutch Shell, currently supplies about 30 percent of the electricity demand of Luzon, the largest and most populous island in the Philippines.

Indeed, geography and economics suggest that the most viable option to monetize Reed Bank gas is the Philippine market. This implies that although China may flagrantly engage in unilateral exploration, it is highly unlikely to unilaterally develop the gas without first locking in the Philippine market. This is politically impossible without Philippine participation, which means that joint development may be the only pragmatic way forward. Manila’s only other option is to hold an offshore licensing round with the expectation of developing Reed Bank through a consortium of international oil majors over Chinese objections.

However, past efforts by the Philippines to unilaterally explore Reed Bank, engage in joint exploration with China and solicit international partners have all proved unsuccessful. In 2004, the Philippine National Oil Company (PNOC) and China National Offshore Oil Corporation (CNOOC) signed a Joint Maritime Seismic Undertaking (JMSU) that included Reed Bank. PetroVietnam reluctantly joined in 2005 as a fait accompli. Yet, the JMSU lapsed in 2008 due to domestic political opposition, corruption allegations and legal challenges in the Philippines.

Since then, bilateral energy relations have deteriorated. In 2011, two white-hulled China Marine Surveillance patrol ships aggressively interdicted the MV Veritas Voyager, a French owned and Singapore-flagged survey ship chartered by UK-listed Forum Energy to survey the Sampaguita gas field in Reed Bank which Forum Energy operated under Service Contract 72 (SC-72) awarded by the Philippine government. This incident was one of several reasons that prompted Manila to file arbitration proceedings against China in 2013. In 2012, Philex Petroleum, the majority shareholder of Forum Energy, approached CNOOC about possible joint development of SC-72. CNOOC declined since a deal would have implied recognition of Philippine sovereignty.

Furthermore, Manila has attempted without success to solicit international partners to help it explore and develop Reed Bank since Philippine companies lack the technology, capital and operational experience to go it alone. In 2014, Manila held its fifth licensing round for eleven oil and gas blocks that included Area 7 located in Reed Bank, but it failed to attract any international players. Then in 2015, Manila ordered Forum Energy to indefinitely suspend exploration due to the pending the arbitration and granted a force majeure on SC-72.

Double-Edged Dilemma

Now that the arbitration award has been announced, Manila will face increased lobbying pressure as well as public support to resume exploration in Reed Bank. Silently capitulating to possible unilateral Chinese exploration is not a viable political option for Manila. The dilemma for Manila will be whether to engage in preemptive or reciprocal unilateral exploration that would almost certainly be forcefully opposed by Beijing and present escalation risks, or enter into negotiations with Beijing on joint development that would risk inciting domestic political opposition as well as disapproval from Washington.

With the recent election of President Rodrigo Duterte, the opportunity for joint development with China seems ripe. On July 5, Duterte repeated his interest in holding bilateral negotiations with China. The newly appointed Philippine Foreign Secretary Perfecto Yasay, Jr. stated on July 8 that the new government was willing to discuss with China options to jointly explore and mutually benefit from disputed resources. However, Yasay had to issue a rejoinder the follow day to clarify his previous comments in response to public backlash for his apparent willingness to share Philippine resources with China. Yasay’s underlying assumptions appear to be that the arbitration award is essentially unenforceable, but may strengthen Manila’s bargaining position in bilateral negotiations with Beijing on joint development.

If history is any indication of future behavior, Philippine public opinion will be strongly opposed to any agreement that is perceived as too compromising on national sovereignty over its offshore resource to China’s benefit. As with the defunct JMSU, joint development would likely be highly scrutinized by the political opposition. These domestic political factors will significantly restraint Duterte’s maneuverability in negotiations with Beijing.

The forceful logic of China’s presumptive position toward Reed Bank is clear: With the Malampaya gas field expected to be depleted in 8-12 years, the timely development of Reed Bank is essential to Philippine energy security. However, time is on China’s side. Through coercion and harassment, China can indefinitely delay the exploration and development of Reed Bank. The Philippines’ only rational option is to agree to joint development with China, albeit on China’s terms, since Philippine companies are unable to develop Reed Bank alone and international partners are reluctant to participate.

If successful, joint development would be a geopolitical victory for Beijing since it would facilitate a rapprochement between Beijing and Manila, make China a critical partner in the Philippines’ long-term energy security, drive a political wedge between Manila and Washington and further weaken ASEAN unity. The downside risks for China is that a heavy-handed play could provoke a public backlash which pushes the populist Duterte to take a strongly nationalist position. In this scenario, Beijing’s gambit would likely have the unintended consequence of scuttling Chinese-Philippine rapprochement while pushing Duterte closer to Washington. This would lock in the status quo, with Reed Bank exploration and development indefinitely delayed and Philippine energy security in a vulnerable position.

Jeremy Maxie is a Senior Advisor at Longview Global Advisors. He tweets at @jeremy_maxie.